Marriott Case Study

Market Rate = . 0872 + (1. 11*.

013) Re = . 0872 + 1. 11(. 10163 – . 0872) = .

10163 Re = . 103 WACC = (. 4 * . 103) + [. 6*.

1002(. 66)] = . 0808792 2. If Marriott used a single corporate hurdle rate for evaluating investment opportunities in each of its lines of business, what would happen to the company over time? If Marriott uses a single discount rate for all departments, Marriott will undertake riskier ventures and invest into more risky stock.

The more risky ventures are more likely to meet that rate. When Marriott invests in those risky ventures, they aren’t accounting for the risk, only for the return.

This can lead to problems because the outcomes can be financially negative – resulting in false NPVs. A false decision like this can increase operating risk in the long run and affect the profitability of Marriott negatively. If Marriott applies this same cost of capital to all three of their business lines (lodging, contract services and restaurants), growth will be affected as well. The only way where the use of a single corporate hurdle rate can be justified is when all projects have the same beta.

This is only true because there won’t be any bias for the estimation of the project.

However, the case study provides us with information suggesting that the projects have different betas and therefore give a wrong answer. If Marriott uses a single hurdle rate for all three lines of business, Marriott will accept negative NPV projects and reject positive, feasible projects. Comparing the IRR with the single hurdle rate will most likely show that the IRR is higher, leading to the conclusion that it is a profitable project. However, if Marriott would actually calculate the beta of the project it might discover that the IRR is not high enough to have a positive NPV.

In conclusion, it can be said that if Marriott uses a single hurdle rate to evaluate all of its projects it will lead to wrong decisions about projects (accepting negative NPV projects and rejecting positive NPV projects), thus decreasing shareholders wealth. Marriott should definitely use different hurdle rates for the evaluation of their projects. 3. What is the cost of capital for the lodging division? Ba = Be/[1+(1-. 34)d/e] Be = [1 + (1-Tc) d/e]*Ba Use Exhibit 3 to find market leverage: Hilton: . 76 = [1+(1-. 34). 14/. 86]*BaBa = .

6863 Holiday: 1. 35 = [1+(1-. 4). 79/. 21}*BaBa = .

3876 Quinta: . 89 = [1+(1-. 34). 69/. 31]*BaBa = .

3604 Ramada: 1. 36 = [1+(1-. 34). 65/. 35]*BaBa = . 611 Average of Bas = .

5113 Overall Be = [1+(1-. 34). 74/. 26]*. 5113 = 1. 47 R = .

0895 + 1. 47 * . 011 R = 10. 567% WACC = . 26 * . 10567 + .

74 * . 1005(1-. 34) = . 0765

4. What is the cost of capital for the restaurant division? Ba = Be/[1+(1-.

34)d/e] Be = [1 + (1-Tc) d/e]*Ba Use Exhibit 3 to find market leverages and Table A for debt rates and debt percentages in capital: Church’s Fried Chicken: 1. 45 = [1 + (1-. 34)(. 04/. 96)]*BaBa = 1.

112 Collins Foods International: 1. 45 = [1 + (1-. 34)(. 10/. 90)]*Ba Ba = 1. 3509 Frisch’s Restaurant: .

57 = [1 + (1-. 34)(. 06/. 94)]*Ba Ba = . 5470 Luby’s Cafeterias: .

76 = [1 + (1-. 34)(. 01/. 99)]*Ba Ba = . 7550 McDonald’s: . 94 = [1 + (1-.

34)(. 23/. 77)]*Ba Ba = . 7852 Wendy’s International: 1. 32 = [1 + (1-.

34)(. 21/. 79)]*BaBa = 1. 1230 Average of Bas = . 9954 Overall Be = [1 + (1-. 34)(.

42/. 58)]*. 9954 = 1. 4711 Re = Rf + (Be*Rp)Rd = Rf + spread Re = . 0895 + (1.

4711*. 018) = 11. 5980%Rd = . 0895 + . 018 = 10.

75% WACC = (. 58*. 11598) + [. 42*. 1075(1-. 34)] = .

970674

5. What is the cost of capital for the contract services division? (Since you don’t have any publicly traded comparable companies, you need to back out a beta for this division using information you have found while answering the previous questions. ) Bm. a = (Wcs * Bcs,a) + (Wr * Br,a) + (Wl * Bl,a) WCS = . 4 * (.

74x + . 4x +. 42x) = . 4 * . 3846 = .

15384 Wr = . 42 * . 3846 = . 1615 Rd = . 069 + .

014 = . 084 Re = . 069 + (2. 956*. 014) = .

110384 .761 = (. 15384*Bcs,a) + (. 1615*. 9951) + (.

2846*. 51135)Bcs,a = 2. 956 WACC = (. 6)*(. 110384) + (. 4)*(.

084)*(. 66) = . 0884064